Defense industry bracing for consolidation

Arnold L. Punaro has sat on every side of the table when it comes to defense issues. A retired two-star Marine Corps general, Punaro worked as staff director for the Senate Armed Services Committee and spent more than a dozen years as an executive at McLean-based Science Applications International Corp.

Now, he’s been named to a two-year term as chairman of the board of the National Defense Industrial Association, a defense industry trade organization.

Capital Business recently interviewed Punaro. What follows are edited excerpts from that conversation:

What made you interested in the chairmanship?

I was not looking for a lot more extra work, but frankly I’ve never been more concerned about whether or not we’re going to end up with a strong national defense in the next 10 or 15 years than I am right now.

Are there concrete things you want to accomplish?

From the liberal all the way to the most conservative, there is a remarkable consensus in the outside analytical community on the kind of changes and reforms that need to occur. But a lot of that has not sunk into the Pentagon or into the Congress. One of the roles that we can play at NDIA is educate and inform to ensure people understand the nature of the problems.

Is military pay the kind of problem we’re talking about?

We’ve gone from a draft-era force in 1973 to the all-volunteer force, and we’ve gradually transitioned in the last decade or so to what I’d call an all-professional force. When you look at the life-cycle cost of an all-professional force, it runs anywhere from 60 to 65 percent of all spending in the Department of Defense. I would like to see us focus more of the compensation on the people who are serving today and make major reforms in the long-term compensation of the people that are no longer serving.

But don’t defense contractors need to be a part of this reform too?

The industrial base will be smaller. There’ll be companies that say we don’t really want to work in this space anymore, we don’t see the return for our shareholders, the government’s too hard to deal with. Some will leave because of budget cuts [and] some will leave because of poor decisions by the government. The government wrings their hands, but when you’re the Pentagon and you’re faced with making the kind of arbitrary cuts they’re being forced to make, they’re not in a position to do things to protect and enhance the industrial base.

Companies are trying to prevent another round of sequestration, but preparing as if it will continue, right?

The companies were well ahead of the government in adjusting to the new fiscal reality. People say, “Arnold, the sequester really doesn’t hurt because look how their stock prices are doing,” but that’s because we cut our overhead, we consolidated, we streamlined, we battened the hatches for tight times way ahead of government. The notion that sequester has not been harmful to national defense is just balderdash.

Do those stock prices send mixed messages?

If you talk to people who are experts in this area, they think that the big companies have got maybe two more quarters before all this stuff starts to catch up.

How will industry reshape? Your old company has already gone through a pretty dramatic reshaping.

We’re in kind of the lull before the storm in [mergers and acquisitions] and downsizing because everyone’s waiting to see: Is there going to be a grand compromise? Of course, the answer is no. I think you’re going to see consolidation in the industry. I think you’re going to see the Pentagon have to relent on allowing consideration of consolidation in some of the top-tier firms.

You think this will go all the way to the biggest companies?

I don’t see how we can avoid that.

How soon do you think we see the industry making these moves?

Late spring, early summer. I suspect in the boardrooms, they’re dealing with this already.